FSOC report prioritises climate-related financial risk

The Financial Stability Oversight Council (FSOC) has identified climate-related financial risks as among its top priorities in its 2021 FSOC annual report.

“In assessing the risks to the financial system, this year the Council has focused on financial risks related to climate change,” the report said.

FSOC categorised climate change risks into two groups: physical risks and transition risks.

“The Council recognizes the critical importance of taking prompt action to improve the availability of data and measurement tools, enhance assessments of climate-related financial risks and vulnerabilities, and incorporate climate-related risks into risk management practices and supervisory expectations for regulated entities,” FSOC stated in the report.

The report also encouraged financial regulators to promote consistent disclosures that allow investors and financial institutions to take climate-related financial risks into their investment and lending decisions.

Through these actions, the report said financial regulators can “promote financial-sector resilience” and “help the financial system support the transition to net-zero emissions”.

Other risk priorities identified in the report include elevated corporate debt, vulnerabilities in short-term wholesale funding markets, real estate, and the transition away from LIBOR.

FSOC said that “risks to U.S. financial stability today are elevated compared to before the pandemic” and that “the outlook for global growth is characterized by elevated uncertainty, with the potential for continued volatility and unevenness of growth across countries and sectors”.

The report follows FSOC recommendations in October which highlighted physical risks to institutions and collateral associated with weather patterns, natural disasters, and climate conditions, as well as the transition risk associated with shifts to new technologies or changes in public policy.

Treasury Secretary Janet Yellen, who chairs FSOC, said at the time that the Council’s recommendations “represent an important first step towards making our financial system more resilient to the threat of climate change”.

Yellen called on economic adjustments to “begin soon”, which included smart government policies to facilitate the transition to a net-zero economy.

“If such policies are delayed and later implemented in an abrupt, disorderly fashion, a rapid revision of perceptions could lead to sudden and dramatic effects on economic activity and asset values,” said Yellen. “The longer we wait to address the underlying causes of climate change, the greater this risk.”

Several US regulators and agencies, including the Securities and Exchange Commission (SEC) and the Federal Reserve Board, have taken significant steps on climate change. The SEC recently consulted on enhanced disclosure rules, while the Fed has set up committees to incorporate climate change risks into its oversight of the financial system, as well as its monetary policy decisions.